As old China slows, new China remains closed to foreign firms: ‘The worst time for multinationals’

More than 30 per cent of members of the American Chamber of Commerce in China have no investment expansion planned this year, the highest rate since 2009, and more companies than ever have moved or plan to move capacity outside of China, an AmCham report said in April.

As China’s old economy slumps, service industries from banking to telecommunications are poised to take up the slack. The catch for American and other foreign firms: They’re locked out of these new growth drivers.

Overseas banks and life insurers have both seen their markets shares slip over the past decade, to 1.7 per cent and 5.6 per cent respectively at the end of 2013, according to Ernst & Young Global Ltd. Foreign ownership of China’s booming telecommunications industry is less than 1 per cent, while law firms from abroad are prohibited from practicing domestic law.

Almost two years after President Xi Jinping championed the biggest market opening in two decades, foreign firms are contemplating a future with marginal access to the new growth engines of the world’s second-biggest economy. Xi meets with President Barack Obama next week during his first state visit to the U.S., with lack of business access adding to tensions that include cybersecurity, the valuation of the yuan and territorial disputes in the South China Sea and East China Sea.

“This is about the worst time I’ve seen for multinationals in China,” said James McGregor, Shanghai-based author of the 2012 book “No Ancient Wisdom, No Followers: The Challenges of Chinese Authoritarian Capitalism,” who has worked in China since 1990. “You now have a very powerful Chinese economy and a powerful Chinese government that seems to be making less room for foreigners and reserving a bit more for Chinese companies.”

At stake for China is its ability to transition to a new growth model reliant more on services and consumption than investment and exports.

Foreign investment played a pivotal role driving China’s rise as a manufacturing juggernaut since it opened to the world in the late 1970s. That was enhanced by its accession to the World Trade Organization in 2001, which opened its domestic market to greater competition and helped power a decade of double-digit growth. Service industries were either excluded from the WTO agreement or opened only fractionally.

“China used the WTO and foreign investment to turn itself into a manufacturing powerhouse,” said David Loevinger, a former China specialist at the U.S. Treasury. “It can do the same with services.”

Concluding a bilateral investment treaty that’s under negotiation between China and the U.S. would be a step in the right direction, said Loevinger, now an analyst at fund manager TCW Group Inc. in Los Angeles.

“While both sides are still far from an end game, Xi’s upcoming meeting with Obama is an important opportunity to gain some serious yardage and move the ball down the field,” he said.

Hopes triggered almost two years ago by the leadership’s vow to give markets a “decisive” role have given way to subdued optimism in an emerging environment of “reform and closing up,” the European Union Chamber of Commerce in China said in a report this month.

More than 30 per cent of members of the American Chamber of Commerce in China have no investment expansion planned this year, the highest rate since 2009, and more companies than ever have moved or plan to move capacity outside of China, an AmCham report said in April.

Free-Trade Zones

Free-trade zones opened in Shanghai and other cities were initially seen as potential breakthroughs for foreign firms to play a bigger role in banking, foreign exchange, logistics and insurance. That hope is giving way to skepticism as promise fails to turn into opportunity.

“The Shanghai Free Trade Zone’s pretty much been a bust,” said Andrew Polk, an economist at the Conference Board in Beijing. “There are some things you can do there as a foreign company, but mostly it just seems about domestic companies’ ability to do financial transactions.”

Even a reform blueprint to revamp state-owned enterprises unveiled this month is centered on continuing government control. Under the plan, authorities aim to reform unproductive “zombie enterprises” while encouraging a “blending” between state-owned capital and private investment, the government said in statements Monday.

The government “desires exactly the wrong thing — more private cooperation with the state sector rather than competition,” said Derek Scissors, a scholar at the American Enterprise Institute in Washington who focuses on Asia economic issues. “The role multinationals are to take is minority investor in a money-losing state project.”

By overhauling bloated, debt-ridden state companies, China hopes to remove a brake on growth in the economy, which is set to expand this year at its slowest pace in 25 years.

In China’s telecommunications market, the only sizable foreign presence is Telefonica’s 2.5 per cent stake in Hong Kong– listed China Unicom, said Michelle Ma, a telecommunications analyst at Bloomberg Intelligence in Hong Kong.

“It is very difficult as telecommunications is a highly regulated and sensitive industry for the Chinese government,” Ma said. “The likelihood for foreign firms to enter the China telecommunications industry in the coming years is quite low.”

There are still bright spots for foreign companies. For example, foreign brands hold a 60 per cent share of China’s passenger vehicle market for the year through July, according to Steve Man, an industry analyst with Bloomberg Intelligence in Hong Kong. Even though that was down two percentage points from the end of last year, the pendulum may swing back in favour of foreign brands in the next couple of years when they are expected to debut new vehicles, he said.

Services Economy

Services are on the rise after replacing manufacturing and construction as the biggest part of China’s economy in 2012. Last year services contributed 48.1 per cent, up from 34.4 per cent in 1994.

Shielding the industry from foreign competition may hamper productivity improvements and make it harder for the sector to lead the economy’s transition and the quest for rich-country status.

“The growth driver of the future, of the next wave of development in China, is supposed to be the service sector and that’s where you find the biggest complaints and biggest concerns,” Joerg Wuttke, president of the European Chamber of Commerce in China, said at a briefing last week. “The feeling we have is that China’s about to renovate its house, but will we be inside the door or outside the door?”

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